How Your MLB Signing Bonus Is Taxed

Jul 21, 2017

For the majority of you, your signing bonus will be your first exposure to a significant amount of money. It will also be your introduction to paying a significant amount of tax.

Your signing bonus presents unique planning opportunities that are often missed in the first year of a player’s career. Unfortunately, for many players in the past, this resulted in losing out on thousands of dollars.

Before the contract is signed, you should be working with your Sports Advisor, a CERTIFIED FINANCIAL PLANNER™ (CFP®) and a Certified Public Accountant (CPA) in determining the most beneficial arrangement.

The first critical piece of information you must understand is how your signing bonus will be taxed.

What constitutes a true “signing” bonus has often been a matter of disagreement between taxpayers and taxing authorities. Taxing authorities routinely challenge taxpayer “signing bonus” assertions, often prevailing under the ruling that the bonus relates to all provisions in the contract, not just the act of signing. If not a “signing bonus,” the income is apportioned as part of regular wages. “Signing” bonuses are not subject to state apportionment if they meet all of the following conditions:

the bonus is not conditional on playing any games for the team;

is payable separately from any other compensation;

and is not refundable.

A true signing bonus is not apportioned as part of wages and is generally taxed to the athlete’s state of residence, which in many cases results in a more favorable outcome.

What Does the Contract Say

Unfortunately, the Standard Minor League Uniform Contract contains a “Recoupment Special Covenant Clause” which makes income apportioned as part of regular wages. In simple terms, your signing bonus is taxed in the state(s) in which you play.

Recoupment Special Covenant Clause States:

“If player fails to report for, or abandons Club without permission and is absent from Club for a material portion, or for at least two weeks, of any playing season (which includes the championship season, any training required by Club in preparation for such championship season and any post-season that the team or affiliate to which Player is assigned participates) during the term of this Minor League Uniform Player Contract (“UPC”),

Player shall relinquish and forfeit any right to, and Club shall not be obligated to pay, any portion of the amount not yet paid pursuant to the payment schedule set forth in this signing provision and

Player shall immediately return and refund to the Club, and relinquish and forfeit any right to, that portion of the signing bonus already paid to Player by Club, regardless of the year of payment, that exceeds the amount of signing bonus already paid to Player by Club (i) multiplied by the number of champion-ship seasons Player reported to, and did not subsequently abandon without permission, Club and (ii) divided by the number of championship seasons covered by the team of this UPC.”

The addition of this language to the contract violates the following two conditions of a true “signing” bonus, resulting in the income being apportioned as part of regular wages:

the bonus is not conditional on playing any games for the team;

and is not refundable.

In summary, your signing bonus is taxed in the states you play NOT only your resident state.

As a simple illustration, take the following 2 scenarios:

True Signing Bonus

Regular Wages

Bonus Amount

$1,000,000

$1,000,000

Team

Miami Marlins

Miami Marlins

Resident State

Texas

Texas

Team Assignment

Batavia (NYPL)

Batavia (NYPL)

Team State Tax Rate

8.5%

8.5%

State Tax (Estimate)

$ 0

$ 85,000

As you can see, the impact of whether a player’s signing bonus is considered a true “signing” bonus versus regular wages carries significant tax consequences. This is only one of the many factors you must take into account when negotiating your signing bonus.

Don’t Be Fooled By The Gross Number

Prior to being drafted, analysis should be prepared in order to determine the true value of a potential signing bonus after-tax. Although the face value of the signing bonus may seem appealing, the actual value after taxes may not be as expected. A quantitative analysis can be prepared for you to calculate the value of the potential signing bonus after taxes.

Your taxes can vary greatly depending on a number of factors including the language of your contract which we just covered, the timing of payment, your itemized deductions and residency.

All of these factors come into play when determining your final tax liability and no two cases are the same. Two players from the same state can be drafted by the same organization but assigned to different teams, and end up with different after-tax bonus amounts.

Timing of Payment

Bonus payments are typically split 50/50 and paid over 2 years. Accelerating or deferring the bonus into uneven payments can generally reduce the overall liability, depending on the circumstances. A common mistake is to always accelerate the total amount into the first year.

To turn this concept into something tangible, here is an example of the $115,800 net-tax savingscreated for a 2013 draftee. This player received a $4,500,000 signing bonus.

Scenario A – Common Approach: $2,597,100 net bonus

The most common approach that teams and sports advisors agree on is for the player to receive his signing bonus in two equal payments over two years. There will be no tax decisions made until the return is filed the following April. In this player’s situation, he would have received a gross amount of $2,250,000 in 2013 and then a second payment for $2,250,000 in 2014. This would have resulted in net-compensation of $2,597,100.

Scenario B – Tax Planning Approach: $2,712,900 net bonus

Luckily, this draftee worked closely with our group and his sports advisor to structure the signing bonus in the most tax-efficient way. He significantly reduced his tax liability by combining an efficient payment structure of the bonus ($4,000,000 in 2013 and $500,000 in 2014) and three additional tax planning strategies. The result was total net compensation of $2,712,900. That is a net-tax savings of $115,800.

Itemized Deductions

Implementing a “skip year” strategy whereby itemized deductions are accelerated or deferred to maximize tax savings. “Bunching” deductions such as sports advisor fees could create more benefit due to limitations placed on these types of deductions. The timing of these payments should always consider Alternative Minimum Tax (AMT), current tax rates and total deductions in all planning years.

State Taxes

Where you live can have a dramatic effect on your overall tax situation. Income tax rates vary by state, with a handful of states currently having no income tax. Professional athletes are subject to taxation in each jurisdiction in which they perform services, making the selection of residency an important planning tool, depending on the source of income. We cover the details you need to know about residency in our article, “Taxation of Professional Athletes: Establish Residency.”

Don’t leave thousands of dollars on the table. Make sure you have a plan in place to mitigate the impact of taxes on your signing bonus.